About 1 of every 8 chief executive officers at the biggest publicly traded U.S. firms leave within three years. Better succession planning could improve longevity and save shareholders billions of dollars.
That’s the conclusion of a white paper published Wednesday by executive search firm Russell Reynolds Associates, which found that 13 percent of CEOs at S&P 500 companies who served from 2003 through 2015 didn’t make it to their third work anniversaries. Of those hired externally, 17 percent left within three years.
Some departures are prompted by personal circumstances, acquisitions or better job opportunities elsewhere. But many are caused by corporate boards failing to map out the future for their companies and develop plans to select and groom candidates capable of taking the helm, said Rusty O’Kelley, global leader of the board advisory and effectiveness practice at Russell Reynolds.
“A surprisingly large number of boards struggle to get this right,” said O’Kelley, who’s also a senior member of the firm’s board and CEO advisory group. “And the cost of an unplanned CEO transition is often very high.”
In the decade since the financial crisis, institutional investors and activists have stepped up pressure on companies to deliver steady long-term results and show a sustainable growth path. Failure to do so can lead to calls for executives, or even directors, to step down. As a result, boards’ patience with leaders who don’t perform has gotten shorter.
A CEO departure, or even a rumor of one, can create uncertainty for investors and employees, and erode a company’s market value, especially if the person in charge is seen as integral to the business, as is the case with Tesla Inc.’s Elon Musk. In addition, companies often must pay significant golden parachutes to executives that are dismissed before their contracts are up.
Thoughtful succession planning helps boards prepare and select the right candidates, decreasing the risk that they will end up with a CEO that doesn’t perform, O’Kelley said. Boards should devise written plans that include shortlists of internal candidates; consider potential external hires to broaden the roster; rotate candidates through a series of top roles to prepare them to lead the organization; and help them build relationships with directors and investors.
The process should start about four or five years before a planned transition, O’Kelley said. CEOs covered in the white paper served an average of 5.9 years, so it can be prudent for directors to begin discussing succession plans with a CEO soon after that person takes the job. The downside is that can be construed by the new CEO as a lack of confidence from the board. As a result, some directors avoid addressing the issue in a timely manner to spare themselves an uncomfortable conversation, he said.
“These are sophisticated companies with top-level directors,” O’Kelley said about the firms covered in the white paper. “But not as many people as you’d guess have gone through a successful CEO transition.”